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Tutorial 1 EC306 Solution PDF

The statement "trade is self-eliminating" is incorrect. Here are a few reasons why: 1. Trade creates gains from specialization and exchange. When countries specialize in producing goods that use their relative factor endowments intensively and trade with others, it allows all countries to consume beyond their production possibilities frontiers. This creates gains from trade that increase real national income and welfare. 2. Trade leads to increased competition which spurs innovation. Exposure to foreign competition forces domestic firms to become more efficient, adopt better technologies, and produce higher quality goods at lower costs. This boosts productivity over time. 3. Trade expands markets. When countries open to trade, domestic firms get access to larger foreign markets to

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535 views

Tutorial 1 EC306 Solution PDF

The statement "trade is self-eliminating" is incorrect. Here are a few reasons why: 1. Trade creates gains from specialization and exchange. When countries specialize in producing goods that use their relative factor endowments intensively and trade with others, it allows all countries to consume beyond their production possibilities frontiers. This creates gains from trade that increase real national income and welfare. 2. Trade leads to increased competition which spurs innovation. Exposure to foreign competition forces domestic firms to become more efficient, adopt better technologies, and produce higher quality goods at lower costs. This boosts productivity over time. 3. Trade expands markets. When countries open to trade, domestic firms get access to larger foreign markets to

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Roite Betero
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© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
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Tutorial 1: International Economics

Topic: Theory of Demand and Supply


Focus: Understand the Demand and Supply and using this concept you need to be able to
solve the equations. Also using graphs you should be able to explain the effect of pre-trade
and post trade scenarios of two countries.
1. If an individual consumes more of good X when his/her income doubles, we can infer that
a. the individual is highly sensitive to changes in the price of good X.
b. good X is a normal good.
c. good X is an inferior good.
d. the demand for good X is perfectly inelastic.
Answer: B

 A normal good means an increase in income causes an increase in demand. It has a positive
income elasticity of demand YED.
 An inferior good means an increase in income causes a fall in demand. It is a good with a
negative income elasticity of demand (YED).
 Luxury good. A luxury good means an increase in income causes a bigger percentage increase in
demand. It means that the income elasticity of demand is greater than one.

2. Suppose good X is a substitute of good Y. Everything else remaining unchanged, an increase


in price of good Y will lead to:
a. an increase in demand for good Y.
b. a decrease in demand for good X.
c. an increase in demand for good X.
d. a decrease in price of good X.
Answer: C
 Complementary Good - If prices go up for Good X, consumers would most likely buy less of
the good Y as well. Since these two products are related to each other, if there is an
increase/decrease in price for one, it would affect the other’s likelihood of being bought as well.
 Substitute Good- If prices go up for Good X, consumers could potentially substitute them for
Good Y, whose price either remained unchanged or even decreased. In this way, Good Y would
be the substitute good for X, because the price of one affects the quantity demanded of the other.
3. Refer to Figure 2.1 below. At a price of $70, the consumer surplus equals:
Price ($/unit)

150
Supply
120

70

40
Demand
10 Quantity
0 100 200 300 (thousands)

a. $6,000,000.
b. $8,000,000.
c. $5,000,000.
d. $10,000,000.
Answer: B
 Consumer Surplus is the difference between the value that consumers place on the
product and the payment that they must make to buy the product. (thus Consumer
surplus equals to the area below the demand curve and above the price line)
CS= ½ *B*H
= ½*200*80
= $8000
4. Refer to Figure 2.1 below. At a price of $70, the producer surplus equals:

Price ($/unit)

150
Supply
120

70

40
Demand
10 Quantity
0 100 200 300 (thousands
)

a. $6,000,000.
b. $8,000,000.
c. $15,000,000.
d. $30,000,000.
Answer: A
 Producer surplus is defined as the difference between the amount the producer is willing to
supply goods for and the actual amount received by him when he makes the trade. (thus
Producer Surplus equals to the area above the supply curve and below the price line).
 PS= ½ *B*H
= ½*200*60
= $6000

5. Which of the following groups is most likely to be benefitted when a country engages in free
trade?
a. All the domestic producers of the country
b. The manufacturers of exportable goods
c. The producers in the import-competing industries
d. The workers employed in the import-competing industries
Answer: B
 The gainers are the consumers of imported products and the producers of
exportable products. Those who lose are the producers of import –competing
products and consumers of exportable products.
6. Suppose the domestic supply (QS) and demand (QD) for skateboards in the United States are
given by the following set of equations:
QS = –60 + 3P
QD = 390 – 2P
In the absence of international trade in skateboards, what will be the equilibrium price of
skateboards in the United States?
a. $66
b. $90
c. $45
d. $150
Answer: B
Qs=Qd
-60+3P=390-2P
3P+2P=60+390
5P=450
5P/5=450/5
P=$90

Two National Markets and the Opening of Trade


7. Suppose the domestic supply (QS) and demand (QD) for skateboards in the United States are
given by the following set of equations:
QS = –60 + 3P
QD = 390 – 2P
In the absence of international trade in skateboards how many skateboards will be sold in the
United States?
a. 138
b. 258
c. 210
d. 930
Answer: C
 Use the price calculated in question 6 and substitute in Qs or Qd equation.
 Qs= -60 + 3($90)
= 210 * You will get the same value if you substitute is Qd equation.

8. Suppose the domestic supply (QS) and demand (QD) for skateboards in the United States are
given by the following set of equations:
QS = –60 + 3P
QD = 390 – 2P
Calculate the change in producer surplus when the United States engages in free trade and
imports skateboards from the rest of the world at a per unit price of $75.
a. +$2,812.50.
b. -$2,812.50.
c. +$3,375.
d. -$3,375.
Answer: B

Price ($/unit)

195
Supply

90

75
Demand
20 Quantity
0 165 210 240 (thousands)

 Draw a graph it will be easier.


 Find New Qs and Qd at Price of $75
Qs= -60 + 3($75) Qs= 290 -2($75)
= 165 = 240

 Find the values for D&S Curve intersecting Y-axis (at Price)
In the main equation LET Qs and Qd be Zero and solve for P

QS = –60 + 3P Qd = 390 -2P


0 = –60 + 3P 0 = 390-2P
60/3 = P -390/-2 = P
P= $20 P=$195

 Change in PS = New PS- Old PS


= (1/2*165*55) - (½*210*70)
= 4537.5 – 7350
= -$2812.5
Two National Markets and the Opening of Trade
Short Answer Questions
Assume that there are only two countries in the world, Pacifica and Atlantica. Both countries
produce and consume surfboards. The pre-trade price of surfboards in Atlantica is lower than the
pre-trade price of surfboards in Pacifica. Draw a three-graph diagram to depict the Pacifica,
Atlantica, and international markets for surfboards illustrating the pre-trade price difference.
Now assume that free trade opens up between Pacifica and Atlantica. Depict a plausible world
price in the graphs. What happens to overall economic welfare in the two countries? Be sure to
label and refer to the graphs in your answer.

Atlantica Pacifica World


Sp Atlantica
Dp
Price Price Price
(supply of exports)
Da Sa 70
Exports P
60 C
Imports Pacifica
40
(demand for imports)

0 30 40 60 0 45 60 75 0 30
Quantity Quantity Quantity

 The above graph illustrates a possible international price.


 The graph to the left represents demand and supply in Atlantica, the graph in the middle
the market in Pacifica, and the graph to the right the World market. Da and Sa are the
demand and supply curves for Atlantica respectively.
 Dp and Sp are the demand and supply curves for Pacifica respectively.
 The international price of 60 is between the no-trade prices of 40 and 70.
 The international price is such a price that the excess supply in Atlantica matches the
excess demand in Pacifica.
 As a result Atlantica exports 30 units to Pacifica at a price of 60.
 Both countries gain from international trade. Atlantica gains area C in the right graph,
and Pacifica gains area P.
From textbook 16th Edition: Thomas A Pugel
Question 7: Explain what is wrong with the following statement” “Trade is self-eliminating.
Opening up trade opportunities drives prices and costs into equality between countries. But once
prices and costs are equalized, there is no longer any reason to trade the product from one
country to another, and trade stops.”
It is true that opening trade bids prices into equality between countries. With a competitive
market this also means that marginal costs are equal between countries. But outgoing trade is
necessary to maintain this equilibrium. If trade were to stop, the world would return to the no-
trade equilibrium. Then price would differ, and there would be an incentive for arbitrage. The
ongoing trade in the free-trade equilibrium is why price is equalized---- trade is not self-
eliminating.
Question 13: The equation for the demand curve for writing paper in Belgium. Questions a-c.

a. With no international trade, equilibrium requires that domestic quantity demanded (Qd)
equals domestic quantity supplied(Qs). Setting the two equations equal to each other, we find
the equilibrium price with no trade.

350-(P/2) = -200+5P
The equilibrium no-trade price is P=100. Using one of the equations, we find that
the no trade quantity is 300.

b. At the price of 120, Belgium’s quantity demanded is 290, and its quantity supplied is 400.
With free trade Belgium exports 110 units.

c. Belgian consumer surplus declines. With no trade it is a larger triangle below the demand
curve and above the 100 price line. With free trade it is smaller triangle below the demand
curve and above the 120 price line. Belgian producer surplus increases. With no trade it is a
smaller triangle above the supply curve and below the 100 price line. With free trade it is a
larger triangle above the supply curve and below the 120 price line. The net national gain
from trade is the difference between the gain of producers and the loss of consumer surplus.
This net national gain is a triangle whose base is the quantity traded (110) and whose height
is the change in price (120-100=20), so the total gain is 1100.
Price ($/unit)

195
Supply

120

100

Demand
20 Quantity
0 290 300 400 (thousands)

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